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SEP IRA 3-Year Eligibility Requirement

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Small business owner established a SEP IRA 3 years ago and the business contributed to the SEP IRA for the owner each year.  During that 3-year period, the small business had no other employees but operated with Independent contractors.  On January 1, 2021, the independent contractors were converted to employees and some additional employees were hired.  The SEP Agreement (Form 5305-SEP) provides, in part, that the employer agrees to provide discretionary contributions to IRAs of all employees who are at least 21 years old and "have performed services for the employer" in at least 3 of the past 5 years.  Does the 3-year eligibility clock for the employees start to run as of January 1, 2021 (when they became employees) or does it go back to the time that one or more of the employees started working for the business as an independent contractor?

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Of course that assumes those individuals were truly independent contractors. If nothing in the relationship changed except the employer "flipped a switch" and presto chango now everyone is magically an employee, then there is certainly some risk that IRS could retroactively reclassify them as employees from the start. Absent one or more of these individuals pursuing/inquiring about this directly with IRS or DOL, the chances of such are probably slim but something of which the employer should be aware I would think.

Kenneth M. Prell, CEBS, ERPA

Vice President, BPAS Actuarial & Pension Services


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